However, despite the upside risks, he expects the Consumer Price Index (CPI)-based inflation to stay below the 4% target.
“This (geopolitical situation) can put pressure on the INR, adding to the risk of imported inflation. To address unexpected developments on the external front, we adjusted our stance to neutral. Moreover, our foreign exchange reserves (about $700 billion) provide a significant cushion,” Singh told ET.
Going by the World Bank forecast and the S&P commodities index, global commodity prices are expected to remain stable, except for gold and oil, he said.
“Food inflation is also likely to follow a downward trajectory. All considered, I expect CPI inflation to stay below the target level of 4%,” said Singh, who is director of the Delhi School of Economics.
India’s retail inflation hit a 75-month low of 2.8% in May, driven down by a steep fall in food prices.Singh said the Reserve Bank of India has a range of monetary, liquidity, regulatory and forex market tools at its disposal to maintain macroeconomic and financial stability in an unlikely scenario of a deteriorating geopolitical situation causing stress on the financial market and putting pressure on the rupee.On June 6, the RBI governor Sanjay Malhotra -headed six-member MPC reduced the lending rate by 50 basis points (bps), taking the total reduction to 100 bps in 2025 so far. It also changed the policy stance to neutral from accommodative.
A basis point is a hundredth of a percentage point.
Singh said he did not believe the monetary policy had moved too quickly over the past six months or so, at a time of increasing global uncertainty. “There was a need for a big cut. Demand for mid-size housing and urban consumption remains subdued. Private investment also remains tepid, despite the massive capex undertaken by the Centre. The capex to net surplus from operations ratio remains below the pre-Covid level.
Singh had backed the rate cut, as per the minutes of the MPC released last Friday.
He also pointed out that given the headline inflation forecast of 3.7% for 2025-26, at the current policy rate (6%), the real repo rate turns out to be 2.3%, significantly higher than what would qualify as a growth-supportive rate.
Due to the Covid-19 effect, the average r* (r-star or neutral real interest rate) estimated for India had increased to 1.65% for the fourth quarter of 2023-24 from 1.2% for the third quarter of 2021-22, he said.
“Now that the Covid-specific factors – elevated public debt and pent-up demand – are behind us, the neutral rate has likely headed toward pre-Covid levels. This gives us scope for a 75 bps rate cut in this cycle,” Singh reasoned.
“Factoring in the global economic and geopolitical uncertainty, a 50-basis-point rate cut in this cycle was reasonable and highly desirable,” he said, adding that limited space for rate cuts does not mean that no more rate cuts are possible in this cycle.
Singh further said, “Having reduced the repo rate by 100 bps, we must carefully assess the macroeconomic situation for additional cuts before proceeding with further cuts, given the elevated risks emerging in the external sector.”
On the surge in bond yields after the MPC’s decision, he said a part of the elevated bond yields for 10-year and longer-duration treasury bonds partly reflect the strong prospects for future GDP (gross domestic product) growth.
“The overall steepening of the yield curve is also a reflection of the bond market’s overreaction to the change in the stance,” he said, adding that the bond market would prefer a situation where it can expect more rate cuts. An alternative course would have been a staggered rate cut, but given the subdued credit growth rate and private capex, it would have further delayed the materialisation of demand and investment decisions in anticipation of future cuts.
“By contrast, a front-loaded 50-bps cut in the policy rate is likely to help achieve the twin objectives of supporting demand and growth by reducing the cost of funds for borrowers,” he said, pointing out that since the MPC decision there has been some (about $5 billion) outflows by foreign institutional investors from the bond market, resulting in hardening of yields and steepening of the yield curve.
“Our rate cut decision is fully justified, coming on the back of strong fundamentals and a stable outlook on the domestic fronts, including fiscal prudence and a benign inflation forecast,” Singh said.
